“The number of mixed signals in this market has been elevated since the pandemic, but it’s gotten worse over the past few weeks (and especially last week). It’s almost as if the same data is looking at two different economies. Certain reports imply solid growth (Empire and Flash PMIs), while others signal a sharp slowdown is occurring (Philly and leading indicators). Some earnings commentary talks about a resilient economy (materials companies such as NUE), while others warn of a looming intense slowdown (CDW). Headline inflation is falling, but core inflation is stable (if not rising). Fed officials are committed to hiking rates in May and are openly saying there will be no cuts this year, yet the market has two to three cuts priced in.” _ The Sevens Report
In recent reviews, I’ve noted that clients have been concerned about the future economy and are trying to understand how one can navigate this type of uncertain environment, so I thought I’d take a moment to try and explain. It’s times like these we need a sherpa and the best guide I’ve found in my career over the past couple of decades is following the “Smart Money”.
Bonds are debt securities issued by corporations, governments, municipalities, and other entities to borrow money from investors. Bond prices and yields are influenced by a wide range of factors, including interest rates, inflation, economic growth, credit ratings, and geopolitical events.
The bond market is considered “Smart Money” on Wall Street because it is larger and more diverse than the stock market and bond market participants are typically very sophisticated and knowledgeable about economic and financial conditions. These participants have access to a wide range of research, analysis, and market data, and they use this information to make well informed decisions about the direction of interest rates, inflation, and other economic factors that can affect bond values.
When short-term interest rates are higher than long-term interest rates for bonds of the same credit quality, we have a condition called an “Inverted Yield Curve”. This means that bond investors are demanding higher yields for short-term bonds than they are for long-term bonds. The yield curve has been inverted since the middle of last year suggesting that “Smart Money” has a pessimistic outlook on the near-term economy believing the Federal Reserve will need to cut rates in the not-so-distant future to keep the economy chugging along, thus implying that some form of an economic slowdown is on the horizon.
The economic slowdown that bond investors are anticipating this time around is the direct result of a decade long financial experiment of extraordinarily low interest rates capped off with economic stimulus engineered by governments around the world. All this “easy money” has led to very high inflation and it’s time for governments to cool things off. As such, I would not expect this potential slowdown to look like those of the early 2000s which led to massive job cuts, bankruptcies, and a bruised credit (lending) market due to asset bubbles bursting.
The stock market has actually been quite resilient despite all the uncertainties having largely traded sideways in a choppy fashion since lifting off the October lows. Participants have been wavering between the idea that we get an economic “soft landing” or “no landing” at all and volatility spikes when “hard landing” data rears its ugly head.
From a technical perspective, the equity markets have shown some upside momentum recently and are trading near recent highs, but one can’t help but notice the overall fundamental picture, with the S&P 500 trading at 18.5X 2023 expected earnings, has valuations a little stretched, or might I say, optimistic at the present time.
Given the uncertain macroeconomic backdrop and optimistic valuations, we have taken our cues from smart money and shifted our investors managed portfolios back to a defensive posture, focusing our stock ownership on the essential products and services one need to live coupled with a lower volatility dividend and income strategy:
- The vast majority of our longer-term bond positions are interest rate hedged and we are enjoying decent yields and price stability from an overweight position in short-term bonds.
- Our Equity Sector Strategy is currently defensive, owning Utilities, Healthcare, Big Technology and Consumer Staples (the essentials).
- Our Core Equity positions are split between Low Volatility, a Dividend & Covered Call Strategy, and Hedged Equities favoring Blue Chip companies.
- Our alternative sleeve consists of broad commodity exposure with a tactical overweight in gold.
- Cash- Our current cash position is around 15%, providing a volatility cushion along with the ability to capitalize on future growth opportunities as they present themselves.
If the past is indeed a prelude to the future, my experience tells me that all these mixed signals from the data are leading to a changing environment. I do not believe the backdrop necessarily spells doom and gloom, in fact, I’m optimistic that we can put this slowdown in the rearview mirror rather quickly. Furthermore, it is a well-known fact that the stock market is one of the best leading economic indicators as it historically rallies before the economy turns. Our current positioning allows the opportunity to participate on the upside, while having the historical tendency to mitigate risk should there be fallout. This strategy also perfectly aligns with the stock markets historical seasonal pattern as the “best six months” of the year give way to the summertime doldrums for the “growthier sectors” as major players spend more time in the Hamptons.
It’s review season here for the next several weeks and you can expect to receive a call from Amy to schedule an appointment. Should you wish to discuss our current strategy (or anything else) in the meantime, please don’t hesitate to reach out to us @ 843-651-2030.